Key views - Global Monthly August 23
The global economy continues to send mixed signals, with weakness in the eurozone contrasting with strength in the US, while China’s post-covid rebound has disappointed. The global economy continues to expand, but the impact of monetary tightening is being increasingly felt, with manufacturing and housing already in a downturn. Tightening credit conditions are weighing on bank lending, which we expect to eventually hit other sectors of the economy. Headline inflation has continued to trend lower, but tight labour markets are keeping core inflation elevated. Central bank policy rates are peaking, but even with rate cuts starting in the first half of next year, we expect monetary policy to stay restrictive throughout 2024. This will keep a lid on any post-slowdown rebound.
Macro
Eurozone – Q2 GDP came in higher than expected at 0.3% qoq. Meanwhile, the Q1 result was revised higher, to 0.0%, up from -0.1%. This means that the eurozone was not in technical recession after all last winter. Despite the somewhat better than expected outcome for GDP in 2023H1, we still expect a considerable period of economic sluggishness, with GDP probably contracting moderately or being close to stagnant during H2 2023 and H1 2024. Core inflation has stagnated in recent months, but should decline during the second half of the year, also because wage growth is expected to slow down.
The Netherlands – Dutch GDP contracted by 0.3% qoq in Q2. Following a 0.4% qoq contraction in Q1 this means that the Dutch economy was in a technical recession during the first half of the year. Dutch GDP is expected to grow by 0.5% in 2023 (revised downward from 0.7%). We expect growth to remain sluggish in the coming quarters on the back of high rates and lower external demand. The Dutch economy remains resilient; the labour market is still tight and bankruptcies – although increasing in recent months – are still below 2019 levels. We expect inflation (HICP) to average 4.8% in 2023 and 3.5% in 2024.
UK – Disinflation has resumed, providing some relief to the Bank of England, but upside inflation risks remain significant given that wage growth has continued to accelerate. Demand has also shown signs of rebounding, with GDP growth surprising to the upside in Q2. At the same time, unemployment has started rising, and we expect a softening in demand to dampen wage growth over time. The economy is expected to broadly stagnate over the coming year or so, weighed by tight monetary policy.
US – We now expect a slowdown and stagnation rather than a mild recession. Growth was unexpectedly strong in Q2, and revised sharply higher for Q1. Meanwhile disinflation has continued, while wage growth has peaked. We now judge that a slowdown and a period of below trend growth will be sufficient to return inflation back to target. But there is significant uncertainty over where inflation will settle in the medium term given labour shortages and residual supply/demand imbalances in the economy. Inflation falling sustainably back to target hinges on a rise in unemployment over the coming year.
China – The reopening rebound in services/consumption has faded, headwinds from slowing external demand and property have intensified, and extreme weather adds to these headwinds. Further impacting confidence/sentiment is the scarring from previous stringent policies (Zero-Covid, regulatory crackdown), as well as ongoing signs of property distress. We already cut our growth forecasts for 2023/ 2024, to 5.2% (from 5.7%) and 4.8% (5.0%), respectively. Although piecemeal monetary easing and targeted support continues, as expected, risks remain tilted to the downside.
Central Banks & Markets
ECB – The ECB raised the deposit rate by 25bp in July, as was widely expected, while also signalling that a pause in the rate hike cycle was likely. Our base line has remained that the peak in the deposit rate (3.75%) has now been reached and that there will be no further hikes. We have shifted our expectation of a pivot in the policy stance a few months forward and now expect a rate cut cycle to begin in March 2024 instead of our earlier forecast of December of this year. We expect that a series of rate cuts will kick off in March 2024, and we continue to see the deposit rate at 2% by the end of next year.
Fed – The FOMC raised rates by 25bp in July, and the Committee made clear that it is open to further tightening. We think July was the last hike of the cycle, and that benign core inflation readings will give the FOMC the confidence to keep policy on hold in September. We continue to expect the Fed to start cutting rates from next March. Even without a recession, falling inflation will push real rates higher, and Fed officials have signalled that this would be inconsistent with the FOMC’s goals. Even with rate cuts starting next year, monetary policy is expected to remain restrictive throughout 2024 and even into 2025.
Bank of England – The MPC stepped back down to a 25bp hiking pace in August, following the surprise 50bp hike in June. We now expect one further 25bp hike in September, and for this to mark the end of the rate hike cycle. However, the BoE is in full data-dependent mode, and UK macro data has been erratic over the past few months. We do not expect rate cuts until next May, and there is a risk that rate cuts get delayed even further, if inflation proves to be more persistent.
Bond yields – US economic resilience led to another bond sell-off, pushing yields to new highs as the market pushes out rate cuts, but on the front-end of the curve, we have seen a pullback in the pricing of additional rate hikes. Our central bank view implies that the short end of the curve will soon need to price in rate cuts for 2024 which will lead to a major drop in short-term rates. Both 10y Treasury and Bund yields are also expected to fall on the back to a flight to quality as economies weaken. However, the decline will be to a lesser extent than the short-end of the curve, leading both curves to bull-steepen by end 2023-34.
FX – We forecast a modest upside of the US dollar versus the euro for the following reasons. We expect rate cuts by the Fed and the ECB next year. Whereas most of the Fed rate cuts we foresee are anticipated by the market, our expected rate cuts for the ECB are not. If our views play out euro should weaken. Moreover, the speculative positions in the euro are extremely large. Our forecasts are 1.08 (end 2023) and 1.05 end 2024.